The Art of Wealth Unbroken

Tax Free Retirement: The Solution

Episode Notes

Last week, Stacey Andres and Jag talked about the problem around tax free retirement.  The government pulled in $3.42 Trillion in 2020.  88% of that went to social security, Medicare, Medicaid, and service on our national debt.  That doesn't even count defense spending, infrastructure, or anything else!

In fact, if you want to see a visual representation of this, you can visit: https://usdebtclock.org/

As we stated last week, the government needs to find money, which means taxes are likely to go up.  And a large potential target for taxes is retirement accounts.

One major solution for investors is to put their money into tax advantaged, or tax free, accounts.  In these Roth accounts, you pay the taxes up front, and then they grow tax free.

Stacey runs through some different retirement scenarios in today's podcast.  Remember, any taxable income you take from retirement accounts creates an additional tax burden, including the chance that your social security income could also be taxed.

To learn more about tax advantaged accounts for your retirement, and how to best plan for a likely tax increase, you can reach Stacey Andres and Michael Wallin at https://www.artofwealthunbroken.com/

Or give them a call at 888-302-5559.

Episode Transcription

Jag: Welcome back in to the Art of Wealth Unbroken. I am Jon "JAG" Gay joined again by Stacey Andres for the second of our two-part series on the problem and solution that we're facing right now, Stacey, before we get today's solution, let's do a quick recap. On last week's episode, we talked about the problem and defining it.

Stacey: Good to be here again with you JAG and yes, when we look at what we talked about last week, just to do a quick recap. When we look at the uncontrolled spending that the government has a massive amount of debt that we currently have. The current liabilities last week, you talked about Social Security, Medicare, and Medicaid, and then just the interest to service the debt. In 2020 those four items required 88% of the total 3.4, $2 trillion in revenue that the government brought in. 

Jag: Let me just stop you there for a second. Stacey. So the government brings in $3.42 trillion. 88% of that money goes to those four items: Social Security, Medicare, Medicaid, service on the debt. And that's before we even get into defense spending or any other big ticket items.

Stacey: Before we get into any other spending whatsoever. Yeah. So it's a little bit scary. If we look at where we're at, well, if we look at where we're going, the reality of taxes going up in the future, in my opinion is very, very real. We could talk about what tax rates have been in the past. And I'll just mention real quick back in the forties upper tax brackets were taxed at 94%.

Don't believe me, look that up online, you will find it. You might be thinking that these numbers that we're talking about, can't be real, that there is no way that these can be real. I would encourage you to go to this website. It's USdeb clock.org. 

Jag: Not to be confused with the doomsday clock, but a couple of similarities in between.

Stacey: There are a couple of similarities. Absolutely. Because what this does is shows you the current income that's coming in now. It shows you all the liabilities, both funded and unfunded liabilities. And if you take a look at the bottom right-hand corner, you're going to see this is scary. That social security currently has unfunded liabilities of $22 trillion. 

Jag: Yikes. 

Stacey: The social security board of trustees for social security actually says that we will run out of money to fully fund social security by 2024.

Jag: That's not good because I turn 54 in 2034. So that's not looking good for me. 

Stacey: And I should be turning social security on by '34.. So, no, it's not good for me either. So if we look at Medicare and Medicaid, they have unfunded liabilities of $34 trillion, and then everything else that the government has committed to over time through all the bills that have passed through the House and the Senate, there are unfunded liabilities of, an additional 168 trillion dollars.

Jag: That is enough to make your head spin. I can't even get my head around that number. 

Stacey: You can't fathom it, you can't fathom it. So just to recap, our country obviously has a very big problem, which means that we as residents of this country also have a problem. We started looking at where else can they go for more revenue?

And one of the big places, when we look and say, okay, there's $7 trillion in tax deferred. 401k, 403B accounts. There's about $14 trillion in IRA accounts. That is, in my opinion, a very ripe target for where they can go to try to get more money in the future. 

Jag: Okay. So, Chicken Little, we've spent the first five minutes of our podcast talking about the problem, which is, I say that half kiddingly because there's actually a lot of truth to what you're saying here, the numbers bear it out, Stacey, but what about the solution? What can we as listeners, investors, citizens do, to deal with this?

Stacey: This is going to vary significantly, depending on who you're talking to, how much income you have, what your net worth is. But the goal is regardless of how much you have, regardless of how much you're making, whether it's $60,000 a year, and you have a couple hundred thousand dollars in savings, or whether you're making a million plus a year and you are worth a hundred million dollars or more. I've been able to help clients throughout those entire ranges, but for the sake of today's podcast, let's just focus on middle America, because this is the group of people that are going to be hit the hardest, that if taxes do increase, they're going to be having an income shortfall when they're in retirement. So for most working families, their main source of income, once they get to retirement is going to be their social security.

Maybe they have some savings in their bank and then really it's going to be looking at what do they have in a 401k, a 403B tax deferred IRA, because that is what through our working years, that is what most of us are pushed toward. So when we talk about the art of wealth unbroken, proper planning really is an art.

It's not just something that you can take a look at one time and say, okay, we're going to be good. Most advisors are very limited in how they approach. But taking a full really, I dunno if I really like this word, but taking a holistic approach to planning is absolutely key.

Jag: I mean, Stacey, I know there are a lot of advisors out there that have, you know, five or six different types of plans for investments for their clients, but you and Mike really take time to get to know your clients and you have the software to run these different projections.

But every individual situation is different, and I know that is very important and key to your business and working with a client to find an individual solution for them. 

Stacey: It absolutely is. It absolutely is. There is no cookie cutter approach that you can take because every person's situation is unique and their needs and their wants both for while they're still here, and when they leave this earth. What they want to leave behind in legacy planning. It's always different. So absolutely. Not having a cookie cutter approach, treating each person, each family as individuals, which they are, is critical. So JAG, I don't know if you are familiar with this or not. If anybody's ever asked you this question, but if you had a million dollars in your tax deferred account, how much of that million dollars belongs to you?

Jag: So just so I'm clear, Stacey, you're asking about, for example, a 401k, something where the taxes have not been paid on the way in, but they're probably be paid on the way out, correct? 

Stacey: Correct. 

Jag: I don't know. A million dollars, five, six hundred thousand could be mine? I don't know. 

Stacey: That's a great guesss. That's a lot better than what I often hear.

Most people will say, "Well, it all belongs to me." And the thing that's interesting about an IRA account, is that you are in business with the government. 

Jag: That's one way to put it. Yeah.

Stacey: If you're 50 years old today and you're looking at retiring when you're 65, the only way that you can tell me how much of that belongs to you is if you can tell me what the tax rate is going to be in the future. 

Jag: And short of having a time machine or a crystal ball, we really don't know.

Stacey: We don't know. So planning to keep taxes as low as possible in retirement is absolutely key. So I just want to go through a couple examples here to show the difference, because what I said, I believe in the last podcast was that if you can prevent your social security from being taxed studies show that your money on average will last seven years longer.

Jag: Wow. 

Stacey: When you think of where most middle America is, maybe having $300,000 to $500,000 in total savings, when they retire. If something goes wrong, they don't have a significant cushion to fall back on. So take a married couple filing jointly. They need $65,000 a year of income. Many of my clients need significantly more than that, or at least they want more than that.

They can't all get more, because proper planning wasn't done at the right time. So let's say that you're looking at your social security statement and your social security between the two of you tells you that you should have $3,000 a month. But if we're looking 15 years down the road and the social security trust fund is out of money.

So we're only getting 78% of what has been projected. So $3,000 a month, $36,000 a year. Times that by 78%. That gives you $28,000 a year of social security income. 

Jag: It's a shortfall of like eight grand. Wow. Okay. 

Stacey: That's significant. Let's say that you're one of the lucky ones that has a thousand dollars a month coming in from a pension.

You have $12,000 of taxable income. So currently you've got $40,000 to take care of the need. You're about two thirds of the way there. Now, if the only other place that you have to go for the additional need is a traditional tax deferred account, you would have to withdraw all of that money. Out of your IRA or 401k, 403B, whatever that is.

Now, once you start taking income, either from a pension, from a job or from a taxable account, like the IRA, the 401k, once you start reaching certain income threshold. Your social security become subject to taxation. And if you have enough income up to 85% of your social security can also be taxed at whatever your current marginal tax rate is.

Jag: So you're talking worst case scenario here, Stacey, not only might you not get as much as you're projected because the coffers might not be as deep, but you also might be taxed on a heck of a lot of it, depending on what you withdraw from those taxable accounts. 

Stacey: Yeah. And this is not necessarily worst case scenario because this is something we see all the time.

I have so many clients, majority of my clients have 85% of their social security being taxed. And so this is commonplace. So here you have an income need of $65,000. You got $40,000 of income taken care of between the social security and the pension in order to make up that additional $25,000 of spendable income, you're going to have to take out over $28,000 from a tax deferred account.

Just to give you that extra $25,000, that would be considered spendable net income. 

Jag: And then of course you're getting taxed on it. When you take it out. 

Stacey: You're getting taxed on the distribution of the IRA, your social security is being taxed. And so that's putting you right in a area paying about $4,000 in taxes.

So that doesn't seem like a lot and to a lot of people, it isn't, but we're only talking $65,000 of income. What if you need 70? What if you need 80? What if you need a hundred? Those numbers just grow exponentially. And so a solution to that is this is just one tool of several that are available for addressing this type of an issue.

What if instead, we just added a Roth IRA into the mix, whether it's your Roth 401k, or whether you establish an individual Roth, just outside. So now the benefit to a Roth IRA is that you pay taxes now when the money is going in, but it grows tax-free and then the distributions from that account are also tax-free.

So now we still have that same $65,000 income need. We still have the $28,000 from social security, $12,000 from a pension. Now let's say we pull out $12,500 out of our tax deferred account. With that, that would give us, between the pension, and the tax deferred account $24,500 of taxable income. But if we look at what our personal exemption is, as a couple filing jointly, we are able to write off that entire amount with our tax exemption.

Meaning at this point we still haven't paid any taxes. So now we go to our Roth IRA for the additional money that we need, which in this case would be, really to the penny, it's $12,420. And now we have $65,000 of income. We've paid zero taxes. We've saved 4,000. And so again, preventing the social security from being taxed also prevents you from putting additional burden on your IRA accounts, your other accounts, money that you have to live on so that it will last longer. When you have more in there to grow again, $3,000, $4,000 a year may not seem like a lot now, but as that has the opportunity to grow and compound over time, they can make a big difference for a lot of families, especially when we're talking middle income America.

Jag: So if I understand this correctly, Stacey, you're talking about a win-win here because if you're pulling this money from a tax-free account, like a Roth, as opposed to tax deferred like the traditional 401k, not only are you NOT paying the tax when you take that money out of the Roth, but that money also does not count toward the threshold of being tax on your social security. Do I have that right? 

Stacey: Yes. And that's a great point, Jag. Cause I didn't mention that. Yes, that will prevent your social security completely from being taxed. It does not count in that fashion. 

Jag: So really this is an incredible tool to definitely take advantage of if you're able to. And if you want to know how that affects your specific situation, you can certainly talk to Stacey.

There are other tools, of course, but first and foremost, that Roth can be so beneficial as we've outlined here as one of the solutions to the problem that we've been talking about both last week and this week. If somebody listening wants to come talk to you about their individual situation and what the best tools and fits for them. To maximize their ability to succeed in retirement. What's the phone number to reach you? 

Stacey: They can give us a call at (888) 302-5559. 

Jag: You can also visit our website artofwealthunbroken.com. That is all one word, artofwealthunbroken.com. Both the phone number and website will be in our show notes. Really good stuff, Stacey. We'll talk again next week. 

Great, thanks Jag!